Case study: Analyzing an average person’s budget and investments

Here's a new thing for me: Yesterday, I met with a friend to give her financial advice. Believe it or not, in the twelve years since I started Get Rich Slowly, nobody has ever asked me to sit down with them and review their budget and investments. Pamela is the first. (And because I forgot to ask her permission to share this info, for this article I am totally changing anything that might identify Pamela.)

I've known Pamela for almost six years. She cuts Kim's hair, and sometimes she cuts mine. She knows I write about money, but I don't think she's ever read anything I've written.

Pamela is 41. She's single. She owns her own business. She loves her work and she's happy with her life, but she's starting to think about the future. Is she saving enough? Will she have enough for retirement? What if she wants to buy a home? Is there anything about her budget that seems out of line? When she cut my hair last month, she asked if I'd be willing to sit down with her over coffee to look at her numbers.

“Sure,” I said. Yesterday, we spent ninety minutes going through her budget and her investment accounts. Because I feel like Pamela's situation is very typical of the GRS audience, I want to talk about

Pamela's Budget

Pamela doesn't keep detailed records of her earning and spending. “Once a year, I take a month to log everything. I want to make sure I'm not out of control,” she told me. “I'm tracking my money this month, for instance. The numbers I have here are rough estimates.”

Pamela earns about $3940 per month cutting hair, or about $47,280 per year. Her business expenses — including taxes — run about $1100 per month. These are fixed, and nothing about them seems out of the ordinary to me. The remaining $2840 per month represents her “take-home pay”.

Of that, $650 goes toward rent. This is a really good number for Portland, and she knows it. She's not happy with her roommate situation right now, but she finds it tough to move because her rent is so low. Anyplace else would probably cost at least $950 per month, and $1200 per month is probably more realistic. For now, she's willing to put up with roommate issues in order to save $300 to $500 per month.

Pamela's second-largest expense is food, which costs her $600 per month. “I could cut that if I had to,” she told me. “I like to eat well, and I know that costs me.”

Her other expenses — clothing, utilities, therapy, and so on — total about $900 per month. (I didn't think to take detailed notes on Pamela's situation because I didn't realize I'd be writing about her.) So, her monthly expenses average $2150, which means she has a surplus of roughly $690. That's awesome!

The bottom line: Pamela earns $3940 per month, or about $47,280 per year. Her expenses (including business expenses) total $3250 per month, or about $39,000 per year. Her saving rate is roughly 17.5% if you include the business expenses in the calculation, or roughly 24.3% if you don't.

I think Pamela's budget is entirely reasonable, but she could always choose to cut spending a little more.

Note: I want to tie this back to my criticism of the Frugalwoods book earlier this week. In my review, I noted that the author was able to achieve financial independence quickly not because her family's spending was $37,000 per year, but because she and her husband have high incomes. Pamela's spending is roughly the same as that of the Frugalwoods, but because her income is in the average-normal range, her saving rate is much lower. This is an example of why income is such a vital piece of the puzzle.

Pamela's Investments

Of the $690 that Pamela sets aside each month, she routes $200 to an Edward Jones brokerage account. This account currently has a balance of just over $42,000 spread across nine different mutual funds. (Pamela really likes her Edward Jones financial advisor.) She also has $11,000 in a credit-union checking account, and another $3000 in miscellaneous investments.

Pamela's advisor has invested her money in the following funds. (I didn't write down fund balances. Sorry.)

Pamela also owns roughly twenty shares of Square Inc. (SQ), which she purchased because she uses and loves their technology in her business. Her $200 initial investment is now worth $800. Plus, she has about $1000 in the T. Rowe Price Science and Technology Fund (PRSCX), which has no load and an expense ratio of 0.83%. (This fund is in a Roth IRA.) These are investments she's made on her own and they have nothing to do with her Edward Jones portfolio.

My initial thoughts on seeing Pamela's portfolio? HOLY SHIT! I'm not joking. I can't help but curse at this asset allocation. I cannot believe that in 2018 a financial advisor would have their client invested like this. It's baffling.

What's the issue? On average, Pamela's $42,000 portfolio carries a staggering 5.31% front-end load and a 0.78% expense ratio. When she sends her $200 to invest each month, roughly $10.62 of that is going to initial fees, leaving her with $189.38 invested. Then, she's losing at least another 0.50% (or $210) per year to expense ratios (when compared to index funds).

All told, Pamela is investing $2400 per year, but paying $337.44 to expenses. That's 13.64% of what she's putting in — not to mention any future earnings that money could have produced. That's great for Edward Jones, but not for her.

Here's another way to look at it (using a new metaphor I'm inventing for this article). It's like Pamela and I are going to race one mile around a track. We know in advance that both of us average the same speed: about 6.8 miles per hour (or about 8:49 per mile). The race should be a close one. Or it would be, except that each of us is handicapped.

Pamela has to carry an extra 78 pounds (representing her average 0.78% expense ratio) and she has to start 280 feet behind me (about 5.31% of a mile).

Assuming we're otherwise physically equal, who do you think is going to win this race? It doesn't take a rocket surgeon to see that Pamela would have to expend Herculean effort to catch me. And the longer we run, the more the difference in the weights we're carrying will begin to tell.

The bottom line: Pamela's budget is great. Her investment portfolio is not. She's losing a ton of money to “drag” each year — and each time she makes a monthly contribution to her portfolio.

My Evaluation

“I'll be honest,” I told Pamela after reviewing her numbers. “I feel like you're doing fine. You don't have debt. You spend on the things that are important to you, but you're not materialistic. You like your work. You don't have a driving desire to retire early.”

“So, you wouldn't change anything?” Pamela asked.

“Well, you could always spend less, right? You don't need a smartphone. You don't need to spend $600 on food every month. Plus, if you took on more clients, you could boost your income.”

“Right,” Pamela said.

“But again, based on what I know of you and your goals, you're doing a great job of balancing tomorrow and today. If there were one change I'd make to how you're handling money, it'd probably be to save more — and to change how you're investing.”

“What do you mean?” she asked.

“You don't want to make things too complicated,” I said, “but if I were you, I'd consider four buckets for savings. First, set aside an emergency fund. You already have $11,000 in a checking account. That's perfect. But I'd also have a savings buckets for short-term goals like your new cell phone and for long-term goals like buying a house.”

“That makes sense,” she said. (I didn't tell Pamela during our meeting, but if I were her, I'd use an online savings account to get better interest rates.)

“Your fourth bucket is for retirement. You're off to a good start there, but you might consider saving even more. And really, I don't like how your money is invested.” I spent five minutes explaining my philosophy of how to invest and describing why I prefer index funds to standard mutual funds.

It didn't occur to me during our conversation, but in retrospect I think Pamela needs to be using tax-advantaged accounts to save for retirement, such as a Roth IRA and/or a 401(k). (The Roth IRA is probably the simplest thing to set up, so I'd recommend that.) Right now, she's putting her money into a regular taxable account. When I next see her, I'm going to recommend that Pamela set a goal of maxing out her Roth IRA. That'd bump her retirement savings from $2400 to $5500 every year. I think that's both smart and doable (even if it might seem like a bit of a stretch).

Overall, I think Pamela makes wise decisions, both with her business finances and with her personal finances. She's smart and level-headed. And again, I feel like she typifies the average Get Rich Slowly reader — or at least where the average Get Rich Slowly is starting from. My hope is that with just a few tweaks, she can give her retirement savings a turbo boost!

In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.

My brother was over during the holidays and asked me to take a look at his fidelity accounts and the funds he’s invested in. He knew I’ve been doing tons of research lately and had no clue himself. I couldn’t believe what I saw. There was $54k sitting in cash. He didn’t realize it wasn’t invested. Reinvesting dividends was not setup for nearly a decade. I can’t imagine how much that cost him, but everyone should take time to at least learn the basics.

If you’d like another case study, I’d love for you to look at my numbers.

Nice job with the running metaphor. It really helps give some perspective on the comparison. It looks like Pamela has been doing pretty well and will be doing better after she gets that EJ account taken care of. Will you suggest she change brokers?

Will I suggest that Pamela change brokers? That’s a tough one. I’ll certainly recommend that she read about indexing so that she can advocate for herself the next time she meets with her advisor. But Pamela likes her advisor, and I don’t want to mess with that. I know how important it is to have a good “team”, you know? I don’t think it’s bad to have an investment advisor. But I do believe that clients must do independent research about broker recommendations.

I hope she doesn’t value his advice no matter how well rated he might be. He has $42,000 spread across NINE accounts with huge loads. That is horrible. With that kind of money, you definitely do not need a broker or adviser. Just split it between a couple of low-cost index funds with automatic deposits each month and call it day.

JD those load fees may look like really high percentages but it’s still only $120 a year for her adviser. If she likes him she must be at least talking to him so that seems cheap for advice. Does she have the skills to do it without advice?

This is a wonderful case study/article and pulls together exactly what you have been writing about lately. She likes her financial adviser because he is a great salesman!! People forget they are being sold something… to their own detriment.

Oddly enough, an EJ rep just knocked on my door (I work from home). I guess they still use that model. He was very nice and after he left me his info, left quickly after I explained that due to my employer, I can’t have money with him (A nice, true, excuse).

My husband works for a small family owned business and his retirement fund management has been all over the place at the whims of his boss/owner. I believe their fees are OUTRAGEOUS (he was charged a $300 line item for one month, though it doesn’t appear to be every month, but almost $1000 in 2017!!), but we’re still trying to figure out that whole thing. I’m not sure how much he can influence things, and the fund manager is a college buddy of his boss/owner…so we have to decide what to do about that. Like Pamela, my husband is very loyal to his boss, so I have to get thru to him that this is real cost directly to us.

I’m another one who really likes these stories and respects people for going out there.

I also appreciate that *Pamela* just seems to live modestly and seems to like saving.

I had a similar experience years ago with some funds at Merrill, when I noticed my account was only squeezing out a 3% return when the rest of the world was making 7-8% (mid 2000’s, maybe). I told my account manager, a man, that I would like my money to make more money and he advised against taking on more risk. I told him I am ok with more risk, honestly I’ve lost more on credit card interest for junk I’ve charged that I should be more upset about than losing money that I’ve invested. I felt like there was some element of sexism from the account manager putting my money in “safe” funds with somewhat high fees, and he was just a tad condescending.

I was mad after hanging up when I considered his words and attitude. So I called Merrill to close the account, and they asked why. I told them the honest truth. And when I told the person on the phone about the conversation that took place and how upset I was about my money’s lack of performance, she thanked me and asked me to hold. When she returned, she introduced me to a female account manager who I liked from the get go. So I began working with her and my money did a lot better. It was the end of the parent/child broker/woman relationship and a real partner. I don’t know Pamela’s funds but maybe sexism is a factor with Pamela’s broker?

I really liked my guy, too, until I compared my returns with those of the market, and got disrespected on asking for better from him. The only one making money was him.

I hope I haven’t jumped to any conclusions about *Pamela* and her broker. It just reminded me of my experience.

She’s getting robbed by her financial advisor. He must be getting commission.
Those investments are horrible. The drag will adds up to real money over years.
This is exactly why I don’t like or trust financial advisor.
It feel bad for her. I’m sure there are a ton of people in similar situation with their financial advisor too.

Totally agree with this. She is getting ripped off by her “financial advisor” and it makes me sick. Her investment management strategy is what definitely needs changing as her monthly budget looks fine. Sure, she could always save a little more more, but I think that is secondary. Overall, I commend her monthly budget.

The bottom line is that she does not need a complicated portfolio with a ton of loading fees and high expense ratios. For example, she would be better off putting into one or two Vanguard funds with expense ratios below 0.1% (e.g., VTCLX). Hope the there are no backend fees with her current allocations, but out of principle, I would drop EJ.

I work at a hedge fund and monitor the markets daily. I have recently taken a more active role with my parent’s retirement accounts and have found a similar situation as Pamela’s – terrible advice or products sold to boost the broker’s fees. Always pay attention to peoples’ financial motivations and the cost of what they are selling.

Liking someone is no reason to invest money with them. I like my mechanic, but if he charged more than other mechanics, AND my car ran poorly after he “repaired” it, I would go elsewhere.

Explaining your investment philosophy was a good way to get her thinking about alternatives, but as someone she came to for advice, I believe you have an obligation to do more. I’d have her read this article for starters. The running metaphor is great. Then show her some concrete numbers so she can visualize what this is costing her. This would also make another great article for your site. Comparing the performance of her portfolio over the past 10 – 15 years with the performance of a recommended asset allocation in index funds over the same time period would be very educational for all of your readers, and it would really help your friend. The final thing she needs is a short reading list to learn some basic investing principles so she can feel confident moving this money to an account where she can invest in some index funds with no load and much lower expense ratios.

Will she have enough for retirement? If her income stays steady, according to the Fidelity roadmap she should have saved at least 3x of her annual income by age 40:https://www.fidelity.com/viewpoints/retirement/how-much-money-do-i-need-to-retire
This would put her on track to reach 10x income by age 67 at which point a 4% safe annual withdrawal rate plus Social Security should replace about 70% of her pre-retirement income.

If her savings now consists of the 42K at EJ plus 11K checking and 3K miscellaneous, then her total of 56K is less than half of 3x her current income. Looking forward saving 8K in today’s dollars annually and invested 60/40 for the next 30 years should bring her on track. But then she should have a higher net worth now had her income and savings rate been steady over the past 20 years.

Reaching her retirement goal requires sticking to the regimen she has in place now, and her balance sheet over time will tell how she’s doing. If things slide for a prolonged period, making up the deficit later may not be reachable.

Goodness gracious, those front-loaded fees! In an age with automated index funds that perform better than matching mutual funds, as well as all sorts of robo-advisors and everything, there is no reason for that sort of nonsense.

If there is a licensing system for financial advisors, that guy should have his license revoked and people really need to take a close look at Edward Jones to see if they’re doing that to all of their clients.

All the financial advisors I’ve dealt with have great personalities and are nice. Bottom line they are salespeople. Pamela is dropping a lot of money in loaded funds now and especially in the future. Plus, holy cow 9 funds! Huge difference in her bottom line from what she has now too if she switched to Vanguard funds with just the loads not even taking into account the expense ratio on those funds.

Great advice for Pamela, I enjoyed the article. I would interject going with Vanguard funds….low expense ratios and no loads. The marginal cost associated with picking up a few additional clients would be low, so acquiring a few extra clients would generate more funds for investing or long-term savings goals.

I love the extra-weight analogy. Shameful to have that many funds spread over $42,000. I agree her advisor is doing her no favors. Tough call on changing the funds though: likely the very-rightest of moves in the long run, but what are the capital gains implications? And it looks like some of the funds with the lower up-front loads may have back end loads. A lot to consider.

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My name is J.D. Roth. I started Get Rich Slowly in 2006 to document my personal journey as I dug out of debt. Then I shared while I learned to save and invest. Twelve years later, I've managed to reach early retirement! I'm here to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you get rich slowly. Read more.

If you like this website, you should check out the year-long Get Rich Slowly course. It contains everything I've learned about saving and investing during 12 years of writing about money. Buy it here.

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